The COVID-19 pandemic has already led to business failures and forced others into negotiations with lenders, landlords and other stakeholders. For many sectors, the crisis has reinforced or accelerated the challenges that they were already facing. Government support measures including loans, furlough and temporary legislative changes have delayed some of the usual pressure points, but as support is eased, many businesses will have to find cash from significantly reduced turnover to satisfy deferred liabilities or repay loans.
Whilst this is unfortunately likely to lead to more businesses failing, it also presents an opportunity for those looking for growth – perhaps the acquisition of a competitor whose balance sheet hasn't fared as well, or opportunities for investment funds seeking new targets at more attractive valuations.
Administration – the basics
Administration is a procedure which allows the reorganisation of a company or the realisation of its assets. A company may enter administration either by court order or by the company, its directors or a holder of a qualifying floating charge over the company's assets (typically a bank or other lender) filing prescribed documents (the out-of-court route). In practice, a prospective administrator will want formal consent from the company's lenders, regardless of who is making the appointment, not least because a qualifying floating charge holder has the power to prevent an administrator's appointment by appointing its own choice of administrator.
The powers of the insolvent company's management cease as administrators are appointed to manage the company's affairs for the benefit of its creditors. By far the most common means of achieving the optimum return to creditors is by making use of the administrators' power to sell the business and assets.
Risk versus opportunity when acquiring from an administrator
As a long-term association with insolvency might further erode value in the business, administrators usually look to secure the best price in the shortest time. A discount on the 'normal market price' is common. However, this discount reflects the legal, operational and commercial risks associated with an insolvent acquisition. The buyer will not have the benefit of any warranties from the seller as to the condition of the business or assets. Even basic aspects of the ownership, quality and the unencumbered nature of the assets will not be warrantied. The buyer is expected to satisfy itself in these respects and accept the risk if it wishes to proceed. A buyer might consider insurance to cover these risks, including synthetic warranty and indemnity insurance (W&I) which is designed to protect the buyer in the absence of warranties from the seller. For more details on synthetic W&I, please look out for the next article in our Distressed M&A series.
An administrator will invariably insist that the sale excludes the possibility of it having any personal liability. Combined with the lack of seller warranties, this means the buyer is unlikely to be able to obtain any remedies if the acquired business or assets do not meet its expectations. At the same time, the buyer will be expected to indemnify the administrator against liabilities that may arise in connection with the sale. This combination of terms can create significant risk for an unwary buyer.
Key issues to consider if acquiring from an administrator
The most commonly encountered issues on acquisitions out of administration are as follows:
- Timescales and exclusivity: Deadlines must be identified, particularly if a pre-packaged sale (negotiated pre-appointment of the administrator) is intended. The acquisition vehicle and funding must be in place early. There is typically very little time to undertake due diligence. Administrators are reluctant to commit to exclusivity (unless the buyer can offer additional consideration, interim funding or a commitment to complete quickly), as it may undermine their ability to secure the best return to creditors.
- Deal structure: A great advantage of buying from an administrator is that it will typically be the target business and assets that are acquired, rather than shares in a company, so the business will transfer free of most liabilities. However, if the administrator has been appointed at parent or holding company level, a buyer may wish to acquire certain subsidiaries in a group by way of share acquisition, particularly if these subsidiaries are the named counterparty on lucrative supply contracts or leases of landmark premises (assuming a share acquisition would not trigger a termination event under such contracts). Buyers should be mindful, however, that unlike a business and assets acquisition, a share acquisition will not allow the buyer to acquire the business free of its legacy debts.
- Employees: If a sale constitutes the "transfer of an undertaking", any rights and liabilities in connection with employment contracts will transfer too. Depending on the number and location of employees, this might trigger certain seller obligations to inform and consult with employees in advance. Enquiries should also be made as to the nature of any pension liabilities, as these can also transfer in certain circumstances.
- Tax: There are potentially numerous tax consequences, including whether or not the transfer is of a "going concern" (in which case no VAT is chargeable) and the apportionment of consideration between categories of assets, which can affect the rate of tax that applies.
- Intellectual property rights (IPRs) and websites: Registered IPRs and domain names will require further documentation to legally transfer so should be progressed early. Passwords, source codes and other vital user information will be required, together with details of support providers. If post-completion assistance will be required from the administrators, such obligations should be explicitly stated in the sale agreement.
- What isn't included?: If the seller is part of a large group, it is important to confirm that the assets belong to the selling company. Administrators may not know whether items are owned by the company or third parties, or the terms of leasing arrangements. Stock subject to reservation of title (ROT) should be identified and priced accordingly. Valid ROT claims can lead to problems trading with too little stock or cash flow problems if suppliers have to be paid.
- Relationships with customers and suppliers: This is essential to ensure that the business can trade post-completion. Many commercial contracts can be terminated on administration, or may not be assignable. Customers and suppliers may want to know why the business failed and ask for assurances that it won't happen again.
- Book debts: Debts owed to the target business are usually retained for the benefit of the administration. In many cases, the debts will not be capable of being collected in full, so if they are to be assigned to the buyer, the price paid for them should reflect this. If debts are not assigned, a buyer should seek assurances from the administrators not to damage future customer relationships by collecting debts aggressively after completion.
- Data protection: It is likely that the buyer will obtain possession of personal data on employees, customers and others in the deal. Customer lists may be a valuable asset, although data protection legislation may restrict the buyer's ability to use such data, in which case further consent from the individuals to whom the data relates may be required.
Close, but no CIGA 2020
The recently enacted Corporate Insolvency and Governance Act 2020 includes a standalone moratorium, restructuring plan and other measures which might be of interest to potential buyers (see our practical guide to the new Act here). The standalone moratorium process, in particular, allows distressed firms to review their financial circumstances without having to decide immediately whether to enter administration or a company voluntary arrangement (CVA), affording an extra period of time to consider available options and these might include a sale if that would mean an otherwise viable business could be salvaged.
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